Tax Credits and Financial Aid: What You Should Know

Getting Student Education Tax Breaks

The American Opportunity Tax Credit, formerly the Hope credit, and the lifetime learning credit are both tax credits that you can claim on your federal tax return. The goal is to help defray the cost of education by reducing your income tax obligation, and if you do not qualify for either credit (as discussed below) you can opt for the tuition and fees deduction, which applies to higher education only and can subtract as much as $4,000 from your taxable income.

For each student in your family, you may claim only one of those three tax breaks each year, so you will have to choose among the three.

American Opportunity Tax Credit

The American Opportunity Tax Credit (AOTC) was an expansion of the Hope credit passed as part of the 2009 stimulus package (the American Recovery and Reinvestment Act). It was due to expire in 2013 but fortunately was rescued in legislative negotiations, and is now guaranteed through 2017. That is good news for taxpayers, because more families are eligible for AOTC as compared to Hope.

In general, AOTC has a higher family income limit and applies to families that do not owe tax. Specifically, the income limits are $80,000 (for an individual) and $160,000 (two spouses) in what the IRS calls modified adjusted gross income (MAGI), which appears on your IRS Form 1040. And the AOTC permits you to claim the credit for four years of higher education, whereas Hope lasted for only two.

The AOTC offsets expenses paid out for not only tuition but also some of your fees and course materials, like books, equipment, or laboratory supplies. The maximum annual credit allowable by way of AOTC is $2,500, 40% of which can be given back to you as a tax refund up to a maximum of $1,000. There is also a list of expenses that are not considered qualified, such as room and board, insurance, and any student fees not necessary to enroll in or attend school.

Most, if not all, of your acceptable expenses will be recorded on your IRS Form 1098-T, which you can request from your school. AOTC can be claimed for four years, but remember that includes any years in which you claimed the former Hope credit. Finally, there are other restrictions on the use of AOTC.

For example, any courses for which you claim credit must contribute toward your acquisition of either a degree or some other type of postsecondary credentials. That is not true for the lifetime learning credit, and the lifetime learning credit is extended to students who have felony drug convictions, whereas AOTC bars those students. AOTC requires that a student attend at least half-time, and as little as one course is acceptable for the lifetime learning credit.

Finally, AOTC states that you must not have completed your first four years of higher education as of the beginning of the tax year.

Lifetime Learning Credit

The lifetime learning credit has income limits of $61,000 (individual) and $122,000 (two spouses) in MAGI. There is no limit on the number of years for which you can claim the credit. Unlike AOTC, the credit is not refundable, meaning you will not receive any money back after taking it (although it can bring your tax liability down to zero).

Any year of education past the high school level is eligible for the lifetime learning credit, including courses you take to enhance your job skills even if they do not lead to a degree or certificate.

The most you can claim annually under the lifetime learning credit is $2,000. As discussed, the eligibility criteria for the lifetime learning credit are quite loose as compared to AOTC, but there are still a few special guidelines that claimants must follow:

• You cannot be a married person filing a separate tax return.
• You cannot be a dependent on someone else’s tax return.
• During the tax year, if either you or your spouse qualified as a nonresident alien the person so qualifying must be treated as a resident alien for tax purposes.

Higher Education Tuition and Fees Deduction

The Higher Education Tuition and Fees deduction has been extended through December 31, 2013, thanks to the American Taxpayer Relief Act of 2012. After that date, be sure to check with the IRS for the current status of the deduction, which is the third way to derive some tax benefit from your higher education expenses.

Itemization is not required in order to use it, and that is because it is a tax deduction (a way to lower the amount of your taxable income) rather than a tax credit, such as AOTC or the lifetime learning credit. The limits on MAGI are the same as those for AOTC ($80,000 and $160,000), and the person for whom the deduction is claimed must be one of the following: you, your spouse, or a dependent on your tax return for whom you also claim an exemption.

Eligible expenses include your tuition plus any fees you must pay in order to attend, but not any personal expenses like housing or food.